Five years on, the jury is examining the evidence on auto-enrolment – and its findings are imminent. Here’s the biggest investment challenges
First – and unsurprisingly – the default strategy has taken most of the strain. Often 99.5% of auto-enrolled employees are invested in it. This can be a good thing. Members invested in default strategies often outperform self-selectors, as they benefit from the lower costs of obtaining advice and investing at scale, and are less likely to succumb to the behavioural bias of selling low and buying high.
Second, markets have been kind to auto-enrolled employees. From April 2012 to June 2017, global stocks have returned 100%, UK stocks 60% and even “safe” UK index-linked gilts nearly 50%.
Indeed, with the best-performing deposit account struggling to provide a 10% return over that period, we can safely assume that few auto-enrolled employees are worse off than if they had placed their tax-advantaged pension savings in the bank.
One leading auto-enrolment provider, BlueSky, utilises a customised version of our target-date funds as a default strategy. After all costs, a member investing £100 on 1 April 2012 would now have between £145 and £173.
This has been achieved with less risk than the market. The volatility of BlueSky’s investments has varied between just over 4% for members in the year before retirement and 9% for younger members. This compares favourably with global equities and index-linked gilts.
Broader comparisons with corporate pensions plans are more difficult. Public disclosure of net-of-fees performance is not a regulatory requirement.
So, perhaps we should call for enhanced standards of disclosure on performance net of fees, and not just fees.
As with all transparency, this should improve market analysis of the investment performance of those responsible for investing the default strategy: trustees, independent governance committees, advisers and asset managers. That can only drive up standards.
Finally, while returns from many default strategies have been good so far, they offer no guarantee of future performance. Instead, default-strategy investment managers must focus on the challenges ahead:
- Setting appropriate objectives for the plan membership as plans mature and the implications of freedom and choice become ever more challenging. We believe this should also include the setting of appropriate benchmarks for monitoring long-term outcomes, medium-term return expectations and short-term market-related performance – not unlike the approach taken by the best defined-benefit plans. A CPI+3% performance expectation is far from good enough, especially when the underlying investments are unlikely to do anything like this in the short term.
- Establishing clear roles and responsibilities for the management of the default strategy, and following good governance principles. The same individuals should not be setting objectives, making key investment decisions and judging performance.
- Ensuring that default strategies are built to be the best, not just the cheapest. Although many have done well over the last five years, a low-cost default strategy that lacks appropriate diversification and risk management potentially could lead to very poor outcomes in the next five years. Trustees should be asking not only whether they have executed as cheaply as possible, but also whether they have spent enough. Those who can only answer ‘yes’ to the first question risk letting savers down and being held publically accountable for doing so.
So, while a 0.1% drop in the charge cap might make our £100 investor 50p better off over the next five years, there could be considerably greater upside from investing in a default strategy that includes more diversification and better risk management.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams. Past performance is not indication for future returns. The analysis provided herein is for illustrative purposes only.
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